US inflation falls to 2.5% in August

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US inflation fell to 2.5 per cent in August, setting the stage for the Federal Reserve to start cutting interest rates gradually at its meeting next week.

The latest annual consumer price index compared with July’s 2.9 per cent pace, and was marginally below the estimate of 2.6 per cent from economists polled by Reuters.

The inflation data marks one of the last major economic releases ahead of the Fed’s meeting on September 18 and paves the way for an expected quarter-point cut to interest rates, which are currently at a 23-year high of 5.25 to 5.5 per cent.

The evidence that inflation is moving towards the Fed’s 2 per cent target is welcome news for the White House and the election campaign of vice-president Kamala Harris, who has been attacked by her Republican rival Donald Trump over the US cost of living crisis.

“Disinflation is an imperfect journey but it’s certainly happening,” said Kristina Hooper, chief global market strategist at Invesco. “I think [the September cut is] going to be 25 basis points because I do believe the economy is on relatively solid footing.”

Core CPI, which excludes volatile food and energy prices, held steady at 3.2 per cent, according to data published by the Bureau of Labor Statistics on Wednesday. Compared with last month, core prices were 0.3 per cent higher, slightly faster than economists expected.

US stocks dropped on Wednesday following the data release, with the S&P 500 down 1.6 per cent by the late morning in New York. The tech-heavy Nasdaq Composite was 1.3 per cent lower.

In government bond markets, the two-year Treasury yield, which closely tracks interest rate expectations, reversed course during morning dealings to trade 0.02 percentage points lower at 3.59 per cent. The benchmark 10-year yield was 0.02 percentage points lower at 3.62 per cent.

Traders increased their bets on a quarter-point cut next week after the inflation figures were published, raising the implied probability of such a move from about 70 per cent to as much as 85 per cent.

But although traders have retreated from earlier expectations of a half-point cut, Fed funds futures markets still anticipate that rates will come down by a full percentage point by the end of the year.

The 0.2 per cent monthly increase in August’s inflation figure was driven primarily by a 0.5 per cent rise in the so-called shelter index, which tracks housing-related expenses. That marked an acceleration after several months of slower increases.

Energy prices fell 0.8 per cent over the month, while food prices rose 0.1 per cent. Services inflation, once energy costs were stripped out, rose 0.4 per cent. Airfares also rose, as did apparel costs.

Lael Brainard, President Joe Biden’s national economic adviser, said the latest report showed that the US was “turning the page on inflation”, which she said was now “coming back down close to normal levels”.

As evidence has grown that inflation is headed back to target, Fed officials have turned their attention from taming price pressures to shoring up the labour market.

Last month, a lacklustre payrolls report for July had sparked fears of an economic downturn in the US, prompting bets that the central bank might consider a larger than usual half-point cut in September.

Those bets, however, have been scaled back in recent weeks.

The data for August, released last Friday, showed that US employers had added 142,000 new jobs that month, up sharply from a downwardly revised figure of just 89,000 for July, although still below consensus forecasts.

“The economy is doing just fine and cutting interest rates too much too quickly runs the risk of another move higher in inflation,” said Torsten Slok, chief economist at Apollo.

He described Wednesday’s inflation figures as “a bucket of cold water in the face of the bond market, which has been carried away with the slowdown story”.

Fed officials have said that evidence of a sharper deterioration in the jobs market could push the central bank to cut rates more aggressively.

Last week, John Williams of the New York Fed and Fed governor Christopher Waller both stressed that a recession did not appear likely for the world’s largest economy.

Williams said that policy was “well-positioned” to respond to any labour market deterioration, while Waller said he expected rate cuts to be done “carefully”, in comments that seemed to indicate both were comfortable with a quarter-point cut next week.

But, Waller added, “if the data suggests the need for larger cuts, then I will support that”.